It’s a cliché, but the good thing about a market decline—especially one that raises the fear level and really shakes out some investors, as we saw recently with the Greece/China mess—is that it’s easy to see which stocks are the real leaders … the stocks that big institutional investors (mutual funds, pension funds, large hedge funds, etc.) are hesitant to sell during the decline, and the stocks the funds rush back into once the pressure comes off the market.
We call these stocks tennis balls—they might drop for a few days when the market is getting hit, but then they bounce right back, just like a tennis ball. These are the stocks you want to focus on … stocks that have the best shot at leading any sustained advance.
Conversely, the stocks that fall hard during the market decline, crashing through key support on huge volume, and then just sit there even after the market rebounds are the eggs. These stocks remain splattered on the floor—institutional investors are still looking to dump shares even as the market bounces.
It’s only been a couple of days, but with the major indexes snapping back since last Thursday, it’s a great opportunity to see which growth stocks are tennis balls and should be put on your watch list … and which ones are eggs and should be avoided or sold.
Ligand Pharmaceuticals (LGND) is a great example of a tennis ball. The stock barely dipped to its 25-day moving average (red line) during the market shakeout, and quickly shot ahead to new highs this week as the market bolted ahead.
Some other tennis balls have deeper pullbacks during the decline, but quickly snap back toward new high ground, which is also bullish action. SunEdison (SUNE) is a good example—the stock fell more than 12% and dipped a bit below its 50-day moving average (blue line) when the market got rough, but has now made up nearly all of the ground it lost in just three days.
On the flip side of the equation are stocks like AO Smith (AOS), a firm tied to the strong construction market (many homebuilders, for instance, are hitting new highs). But instead of rallying, the stock collapsed on huge volume when the market was weak, and you can see the recent bounce has been meager. AOS is an egg and looks like a sell on this bounce.
The bottom line is that the recent market shakeout allows you to use the market’s own evidence to your advantage. Focus on stocks that held up well and/or have rebounded strongly during the past few days, while avoiding and/selling those that fell hard and are having trouble getting off their knees.
Both Ligand Pharmaceuticals and SunEdison have fantastic growth stories and are on my watch list in Cabot Growth Investor.